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I received informative emails in response to yesterday's post regarding a Bloomberg news investigation finding that Mitt Romney employed a charitable tax avoidance device that has since been eliminated by the IRS.

Both Russel Willis from Portland, Oregon and William Gray from Richmond, Virginia wrote that the Bloomberg report -- and I -- had missed some important nuance. Attorney Gray's explanation was quite detailed, so for the tax junkies among you, I will quote it in full:

"CRTs were authorized by Congress in
1969 as part of the major revision of the EO rules that carved out private
foundations from the universe of charities for special treatment. In
fact, funding a CRT is one of only nine ways that one can get a charitable
contribution for giving away less than one's entire interest in an
asset. Pursuant to IRC sec. 664, the trust pays one or more designated beneficiaries
either a fixed dollar amount or a fixed percentage of the trust asset value
annually for life or a term of years, and then whatever is left in the trust is
distributed to one or more designated charities. The grantor is eligible
for an income tax deduction under IRC sec. 170(f)(2) based on the
actuarial value of the remainder interest, discounted to reflect the term of
the trust, the income payout rate, IRS assumed interest rates,
etc. Comparable deductions are available for gift, estate and GST
tax purposes.

CRTs are useful planning tools for
individuals who would like to make a gift to charity and receive a current
deduction but who also want to reserve a stream of income for themselves or
others. CRTs also are tax-exempt trusts, so donors can fund them with
appreciated assets and avoid any capital gain tax when the CRT sells the
assets, leaving the CRT with $1.00 to invest rather than the $0.80 or less the
donor would have had if s/he had sold the asset and then given or invested the
proceeds. In the late '80s or early '90s, aggressive planners began to
focus on this capital gain avoidance feature, whether or not their clients had
any real charitable intent. Using a creative reading of the trust
distribution rules, they designed short-term, high-payout CRTs (e.g., a
two-year trust with a 80% annual payout) that allowed the donor to recover
substantially all of the value of appreciated assets with little or no capital
gain tax liability. In 1997 Congress determined that these
"accelerated CRTs" were abusive and inconsistent with the
purpose of the CRT rules, so it amended IRC sec. 664 to limit annual payouts to
50% and to require that the charitable remainder have at least a 10% actuarial
value.

I have not seen the terms of the
Romney CRT, but the Bloomberg description indicates that it was not an
accelerated CRT but instead was intended to last for the Romneys'
lifetimes. As a "unitrust", it pays 8% fixed percentage of the
annual trust value rather than a fixed dollar amount. While 8% may seem
an aggressive payout by today's standards, I note that the IRS
assumed interest rate for June 1996, when the CRT was created, was
8%. The relatively low charitable deduction allowed (coincidentally also
about 8% according to the article) would have resulted primarily from the fact
that the designated charity was likely to have to wait 30-40 years or
longer before the trust would terminate.

The dwindling value of the trust, as
reported in the Bloomberg article, may be largely a result of the trustee's
investment performance and subsequent economic conditions. An 8% growth
assumption, used in the actuarial calculation, has proved not to be realistic;
and many CRTs established in the '90s have seen their values decline
significantly. I note that the unitrust form allocates decline
proportionately between the income beneficiaries and the charity, while the
"annuity trust" form, the other permissible variety of CRT, would
have placed all of the burden on the charitable remainder since an annuity
trust is obligated to pay the income beneficiaries a fixed dollar amount
regardless of how much the underlying principal value declines.

The Bloomberg article is misleading
in implying that this trust was the type of abusive technique that led to
the 1997 restrictions on CRTs or that all CRTs are somehow suspect or
abusive. The Blattmachr comments contribute to that impression because
the article does not make clear that they refer primarily the short-lived and
abusive "accelerated CRTs". I have no grounds for speculating
on what combination of financial, tax and charitable considerations motivated
the Romneys; but I can say that the type of CRT described is one that
reputable planners might have recommended to their charitably-minded clients in
1996. As the article admits at one point, it was "legal and
common among high-net-worth individuals."

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Comments

Thanks for following up on this. I also thought that the Bloomberg and Chronicle stories were misleading,and am glad to see this clarified.

Posted by: Rebecca | Nov 1, 2012 4:24:10 PM

Pace the commenter, who is otherwise spot-on and adds some very interesting color, capital gains are deferred, not eliminated. The trust sells the capital gain, and then creates an "accounting reservoir" for the capital gains. When the unitrust or annuity interest is paid back to the grantor, the accumulated capital gain follows the distribution and is taxable to the grantor (see IRC 664(b). In light of that, I'd think that savvy tax planning would favor exactly what Governor Romney did: create a low remainder amount in order to max out the payments back to the grantor, but create the longest possible unitrust/annuity period in order to maximize the value of deferral. And we can tell from the return that Romney has already recaptured all of his gains, since there was no capital gain from the CRAT reported on his return.

It's clear that what Romney did was perfectly legal and in line w/ what the statutes permitted him to do, but, while I wasn't around when the relevant remainder language was added, Romney's CRAT would seem to me to be precisely the sort of vehicle that the amendment was aimed at eliminating.